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Brexit or Not, Uncertainty Costs

James Saft / Reuters No Comments Share:

In or out, Britain will pay a price in delayed investment and consumption and increased volatility simply because it is voting on its European Union future.

Slated for June 23, the Brexit referendum is tough to call and impossible to ignore. Polls give the “remain” camp an insecure single-digit lead and predictions derived from political betting imply a 65-70 percent chance UK voters opt to stay.

Polls and market prices are a poor security in comparison with the size of the issues at stake, implying that some households and particularly businesses will delay decisions and consumption until after the election, curbing output regardless of outcome. Financial markets have already moved, sending the pound lower against other major currencies, and will likely become more volatile in the run-up to the vote.

To be sure, the impact ahead of the vote will only be a small fraction of the hit to growth Britain would suffer if it voted to leave the EU, but a small percentage of a very large number is still substantial. That’s because a ‘leave’ vote will produce a mare’s nest, as Britain must negotiate the terms of its exit with the EU, a process which would last at least two years and include numerous separate risks in numerous countries. That’s even before we consider that a vote in favor of Brexit would likely bring down Prime Minister David Cameron and quite possibly result in a vote by Scotland to leave Britain.

During the time after a “leave” vote, British relations with Europe would run more or less as they do now but no-one would really understand for how long and what comes after. So while companies inside and outside Britain would want to continue to do cross-border business, their ability to understand the costs and benefits of that would be highly impaired.

That’s enough of a risk to tilt many towards putting off investment until matters become clearer. After a vote, this impact will be magnified, according to Kallum Pickering, an economist at Berenberg Bank.

“It is very likely that UK economic conditions deteriorate in the short run, despite no real change to the UK’s EU status, because economic participants will begin to act in accordance with their long-term expectations, which will be materially weaker,” he wrote in a note to clients. Even though a vote to leave would hit sterling’s value which may drive inflation higher, the Bank of England may well react by loosening policy – either actual interest rates or through more quantitative easing – in a bid to short-circuit what could easily be a self-fulfilling descent into recession.

Societe General estimates a 0.50 to 1 percentage point annual hit to British output for a decade following a vote to leave the EU, with a notable hit to exports due to increased tariffs and tougher and more uncertain conditions for Britain’s huge financial services industry.

None of this is, of course, inevitable, nor is it to say that Britain will necessarily do worse outside the EU than it would if it remained. The future of the EU itself is far from clear and secure even putting aside British willingness to remain, and trade policy, which would be one of the biggest uncertainties after an exit, is at a particularly unstable period globally. One need only look at the election in the US to see that the rules of trade and globalization as they’ve been developed and followed in recent decades are by no means a permanent reality.

That’s all highly speculative, but what isn’t is that uncertainty over what the UK is and does is as high as it has been in the career of all but the longest-lived investor.

And where there is high uncertainty, the easy bet is growing financial market volatility. On some measures, markets are now pricing in the highest amount of volatility on the FTSE 100 index of shares seen in the past 15 years, a period which included the September 11, 2001 attacks and the greatest financial crisis since the Depression. That kind of volatility is costly now and, if sustained, would rise in impact.

And all of this is before we consider that a vote to leave would have an impact far beyond Britain, raising difficult-to-answer questions and difficult-to-pay costs for a Europe already struggling politically and economically.

These are the kinds of issues that rightly make people and companies pause.

Everything in Britain may well stay the same, but while the costs of leaving look higher, there will be bills either way. – Reuters (Mr. Saft is a columnist for Reuters.)

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